Forum Topics The Case for including high-quality gold producers in your portfolio
RogueTrader
5 years ago

Great post Bear77!  I'm a non-expert on gold producers, though I've got a fairly substantial position in AMI.  Do you consider the charts at all when making buying decisions, or only fundamentals?  DCN for example looks rather bearish at the moment, having substantially underperformed the XGD in the last few months.  AMI's chart on the other hand looks very bullish, being a nice uptrend constantly stepping up to higher levels, with volume greatly improving over the last few months (rather similar to NST's chart actually.) 

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Bear77
5 years ago

Thanks Doodlebug (a few posts up) for the positive feedback. Sorry RogueTrader, I missed your post 8 months ago it says now - I got out of AMI when they started falling back down, and then stopped following them, as they seemed to lose their way from a management point of view, I do look at charts when looking to enter or exit a stock, but it's a secondary consideration, and DCN were certainly bearish, but I held them until the trading halt and the massive guidance downgrade. I sold into the opening auction when they hit the boards again after that announcement and got the opening price of $1, well below my average price paid, and they closed that day at around 50c from memory (which is what I got on my Strawman scorecard for my DCN exit price). They've bounced from there on a new discovery and some better news, but I won't go near them again. Management credibility is shot to pieces in my view based on the magnitude of that downgrade - both in terms of ounces and costs. I currently hold NST, EVN, SBM, and PNR. I also own IGO and WSA. IGO and WSA are both nickel miners, but WSA have just bought a gold project as well, and IGO also own 30% of the Tropicana gold mine in WA that is 70% owned and operated by AngloGold Ashanti (AGG). IGO also produce copper and cobalt at their Nova nickel mine. I also hold Codan who own Minelab who make the world's very best gold detectors. I also hold LYL (Lycopodium) and GNG (GR Engineering) who both design and build gold processing plants. If you want to see what the A$ gold price tailwind can do for a company, have a look at Codan's 1-year chart. That is mostly just on the back of increased gold detector sales globally. Many of these companies look expensive at current levels, but they are often the ones that go up against the tide when the vast majority of the market is falling hard on days like yesterday (Tuesday 6th August 2019) and the day before. I don't currently hold any gold explorers or gold project developers other than the producers I've just mentioned (NST, EVN, SBM & PNR). I'm currently playing the developers via the engineering companies that build the plants (GNG & LYL). I also own some mining contractors like MAH (Macmahon) who mostly work for gold miners. NWH is another one I own who have some gold mining clients as well. I like to have some direct as well as some indirect exposure to the sector at all times, but especially right now!!

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Strawman
5 years ago

An important distinction Bear77, and it was a little spurious for me to lump them together.

I have to admit, a often struggle to overcome certain investment prejudices, and it's a big weakness. Well reasoned arguments like the one you've made her do help though -- so a big thankyou!

 

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Strawman
5 years ago

I've never been a fan of Gold miners, but it's hard to dispute the phenomenal gains these companies have delivered. Thanks for sharing Bear77.

In the ones I eyeballed, it seems these were examples of miners that pivoted successfully from prospectors to productive miners, and were run with a tight operational focus. They certainly deserved their success.   

Just as a counterpoint, more just to give a different persepctive than to get into a debate (each to their own, i say), i'd add some thoughts:

Gold miners, and miners in general, are almost always amongst the best performers over time frame, because the leveaged gains are massive as they transition from loss making, cash burning enterprisies to highly profitable, cash gushing businesses.

BUT, as a group, these are very much statistically in the minority. The exception that proves the rule, as it were. An analogy is kinda like lottery tickets -- they give the most amazing ROI when they hit, but the odds of picking the right one are very low. For every NST there are 100 miners that only destroy value.

The net present value of a gold miner is typically well below industrial companies of a comparable profitability, because although a miner can make great return when their reserves are productive and the commodity price high, eventually it will deplete and then you need to reinvest a bunch of money into a new asset, and face all of the same challenegs again to make it productive and generate a good ROI. VERY hard to do that consistently. The market will often extrapolate current rates of profitability unreasonably, so these companies can be highly overvalued even when they are at peak profitability. 

That being said, although they are not for me, I can see great value for investors that look for exposre to Gold miners. But I would argue that you dont just go gold for the sake of gold. Go gold because you have done a lot of reserach on the underlying business and have good fundamental reasons to expect an increase in free cash flow in the years ahead. 

Anyway, my 2c :)

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Bear77
5 years ago

Thanks for that Strawman, and you make some valid points. However, I think it's important to make the important distinction between the gold explorers and the gold producers.

The explorers are the high-risk plays that statistically will lose money for most punters.

The producers are a different story. The high-quality producers, being the ones with good TSRs over multiple timeframes, are not in the same category at all. That was the point of my forum post - to talk about the high-quality gold producers, not the entire gold sector.

There is also a grey area, which are the developers. The developers have found gold, and are all at various stages of developing - or attempting to develop - those gold deposits into producing mines. They are less risky than the explorers, but still high-risk "investments" (some would say they are still a gamble rather than an investment). The level of risk depends on the quality of the deposit and the stage that they are at with the development - plus many other factors.  It's also good to have a feel for management with such companies - what they have achieved previously - and how shareholders have benefited (or not) from their efforts in the past.  Many of the developers go the same way as the explorers - and lose money for shareholders. Many developers never achieve any gold production - at all - ever.  That could be due to a variety of factors.  The economics change (eg. Carbine Resources - ASX: CRB);  They can't get the necessary finance to build the plant;  The board gets hijacked (eg. KIN Mining - ASX: KIN).  There are other reasons also. 

Carbine Resources (ASX: CRB) is a good case study of a company that the vast majority of shareholders would have lost money in (including myself). In their case, they went from being a future gold producer that was going to have one of the lowest AISCs (all-in sustaining costs) in Australia (of A$549/oz) to a shell trading at less than 3 cents/share - after an economic review of their project showed that their AISC was actually going to be 57% higher - primarily due to higher cyanide consumption and lower byproducts credits. Their earlier feasibility study was flawed, and they had already signed offtake agreements for future production based on that flawed FS data. They were unable to renegotiate those contracts. They also didn't yet own 100% of the site. They had an agreement to purchase it (the parts they didn't already own), but that depended on successful financing, which, in turn, depended on favourable project economics. When the project economics changed, it became clear that they weren't going to achieve funding, so the whole project ground to an immediate halt. That was back in March, and the share price of CRB dropped 56% from 8 to 3.5 cents, and has just kept drifting south since then. Hopefully, people can see from this one example that many things can and do go wrong - even with gold project developers who claim to have wonderful economics for their projects.

However, I am not advocating people buy project developers or explorers (who are not already producers). I am simply suggesting that including one or two proven high-quality gold producers with good management - and an exemplary track record - in your portfolio can (and should) improve your returns. It has proven to be the case for me in both bull markets and bear markets, and especially in times of increased volatility, such as in October 2018 (the month just ended) when the DJIA (the DOW) dropped by 5.5%, the Australian S&P/ASX 200 accumulation index fell 6.1%, our All Ords dropped by 6.5%, our Small Ordinaries index fell by 9.7%, but our Gold index (ASX: XGD) rose by +7.6%.

Over the month of October, NST's SP rose by +5.8%, EVN was up +12.5%, RRL rose +13.4%, SBM rose +19.2%, and SAR rose +31.4%.

While still thrashing the broader market, NST was the only one of those high-quality gold producers to underperform the XGD (the Australian gold index) in October purely because they (NST) rose +19.3% in September (due to the announcement of the Pogo acquisition) when the XGD only rose +1.2%. NST overshot to the high side in September and then had a mini-correction of sorts during October (they rose, but not by as much as their peers).

In summary, when looking at the sector, they are not all created equal. There is a wide variety of options across the risk spectrum. There is far less risk with proven high-quality producers who have no net debt, plenty of cash, proven reserves, good management, the best mines, the lowest costs, and outstanding track records of total shareholder returns. Those are the companies that I am talking about here - as possible inclusions as part of a balanced portfolio.

I agree that explorers and developers are risky propositions and the odds are not in your favour.  However, I would argue that with companies like NST, EVN, SBM, SAR & RRL, the best of the producers, the odds are most definitely in your favour.


Edit:  Additional:  I think that part of what Strawman was pointing out in his forum post above this one is that these fabulous TSR numbers for gold producers often include earlier periods in which these gold miners transitioned from being loss-making explorers to developers and then to producers, so they go from loss-making to gushing cash, and that's a fair call.  However, if you look at the TSRs over shorter periods - such as 1, 3 or 5 years - during which time these companies have been gold producers (have been consistently profitable), the numbers are still outstanding -  and it becomes clear that these companies have much more favourable economics than the vast majority of industrial companies in our market.  

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Bear77
5 years ago

No problem at all Godders.  I'm glad to hear it has helped someone.  I don't hold any physical gold or gold ETFs but I do like holding some gold miners in my portfolios.  The advantages, in my opinion at least, in holding gold mining companies over gold bars are:

  1. These companies do own a lot of gold - it's just that most of it is still in the ground.
  2. It's a leveraged play.  If the gold price rises in Australian dollars, our best gold miners often rise by more as people extrapolate how much extra profit they are going to make.  That also works against you when the gold price falls of course.
  3. If you choose one or two of the best ones, then you are going to own a portion of one or two real companies, who are highly profitable, with good ROEs, and good management who make sensible capital allocation decisions, and they usually pay fully franked dividends.
  4. The really good ones (NST, EVN, SBM, RRL, SAR) have outperformed the vast majority of every other company in our market over most time frames (up to 10 years).  That's not always true of physical gold.

The reason why the share price of a company like NST (for example) can do better than the underlying price of the commodity that they produce is that as well as their exposure to that commodity (gold, in this case), their share price is impacted by the decisions of their management (Bill Beament, in this case), which includes M&A activity and capital allocation decisions.  The best managers of these companies run them as businesses first, and miners second.  As businesses, they need to remain profitable, remain relevant (which includes staying ahead of most of the pack), strive to increase their profitability, and regularly reward their shareholders (via both income and capital appreciation on their investment).

Here are the TSR numbers (Total Shareholder Returns, which are straight from CommSec today) for those 5:

Company, 1 year TSR, 3 year TSR, 5 year TSR, 10 year TSR

  • NST, 71.8%, 50.3%pa, 61.7%pa, 82.1%pa
  • EVN, 35.9%, 34.1%pa, 35.2%pa, 30.4%pa
  • SBM, 55%, 50.8%pa, 57.2%pa, 13.5%pa
  • SAR, 67.7%, 61.4%pa, 60.6%pa, 44.1%pa
  • RRL, 17.3%, 33.6%pa, 8%pa, 53%pa

These TSRs do include dividends, and SAR don't pay dividends (yet).  The others do.  While SAR still have outstanding numbers, I personally prefer to see my gold producers returning some of their profits to shareholders on a regular basis.

Look at the consistency of EVN, and the unbelievable numbers of NST.  If there are ANY companies out there with better TSRs than NST over all of those timeframes- I'd really like to hear about them!

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Bear77
5 years ago

Thanks Doodlebug. I totally agree that the best gold producers (that provide the best returns consistently) are the ones with the best management. Jake Klein at Evolution and Bill Beament at Northern Star are stand-outs. I also rate Bob Vassie at St Barbara very highly. Congrats at buying NST at 36c Doodlebug! They closed at $13.34 today, so that's a tidy +3,700% gain. I owned some Gascoyne (GCY) during the construction phase, but sold out when the commissioning started. I wasn't impressed by their management. I do own NRW Holdings (NWH) shares and they have some exposure to GCY - including owning 8.58% of GCY and having loaned them $10m (a second ranking secured loan), plus the working capital they have tied up in the mining services contract at Dalgaranga. I have owned ZEN shares off and on also, and ZEN have some exposure to GCY also via the PPA there and the power plant that they operate at Dalgaranga. I guess the learnings from Gascoyne and Dacian (GCY & DCN) are that when a developer becomes a producer, it's best to allow them to get a few reports under their belt and for their gold plant to be consistently running at nameplate capacity for a year or three before you consider them to be in the same league as the established producers who have many years of production under their belt. Other new additions to the producers list include AMI, GOR & PNR, and I consider those to be high risk also compared to the top end producers like EVN, NST, SBM, SAR, RRL, etc. I hardly ever mention NCM (Newcrest Mining), Australia's largest listed gold producer, purely because I don't like their management, ever since they bought Lihir, so I pretty much just ignore them - but I do note that their shareholders have also done alright over recent months. If you haven't got the time to do the research, stick with the biggest, which currently means ASX-listed goldies with market caps over $1.5 billion, which means the following 7: NCM, NST, EVN, SAR, RRL, OGC & SBM. Of those I don't like NCM or OGC (OceanaGold) much, but they are safe enough to invest in. Those with the best management teams IMHO would be NST, EVN, SBM (I own shares in those 3), and then RRL & SAR. Ben Griffiths from Eli Griffiths likes SAR and raves about their management. If you fish within that pool of 5 (who all have market caps of over $2 billion currently), you are definitely playing at the safe end of the sector. That said - they ALL look expensive right now (17 August 2019). And they'll probably all get MORE expensive too, in the short-to-medium term at least. Gold stocks are always best bought when the gold price is down, not when it's flying at over A$2,100 like it is now.

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